Emerging markets monetary policy risks ‘currency war’

7th December 2010

Philip Poole, global head of macro and investment strategy at HSBC says the currency interventions we have already seen, as governments and central banks in the emerging markets take steps to stem the flow of investment into their economies, could have serious implications.

"The message from the recent Seoul G20 meeting seems to be that policy makers are still struggling to prevent a potential escalation in this currency war rather than being in the final stages of making peace," he warns.With policy and market rates so low in developed markets and growth prospects less-than-promising, when investors search either yield or growth they are increasingly drawn to emerging markets, where the fundamental outlook is stronger and where inflation, rather than deflation concerns, are driving up interest rates.

The emerging markets have retaliated to the flow of interest from foreign investors with currency intervention. But that does not come without its own risk. And China is not the only one to take such measures. Brazil, Russia, South Africa and even Poland are among the countries taking steps to stop heavy inflows of foreign investment damaging their economies, as reported here in The Daily Telegraph .

As HSBC's Poole says: "The intervention itself only redirects the pressure. It does not remove it. The likelihood is that it will generate inflationary pressures.

"The starting point for such a development is the very loose monetary policy in the developed world combined with China's currency intervention policy. "

Now he believes that mounting frustration from the US over what it sees as unfair emerging market currency policies could boil over. Poole says these "tit for tat measures", aimed at protecting currency competitiveness could more easily end up in protectionist measures on trade.

As this Reuters blog mentions, when it comes to battles everyone wants to be the winner .

Trade war was mooted back at the start of November in this article on stockmarketdigital.com that looked at the possible repercussions.

And it is true that steps taken by China and other emerging markets can have serious implications on a global basis. As Poole says, the question is: "Will US frustration with what they see as ‘unfair' emerging market currency policies, particularly in China, boil over into measures that start to roll back the boundaries of free trade?"